Are you stretched to the limit?

Back-to-back interest rate rises are visibly taking their toll on many Australian households, as shown by the soaring levels of mortgage stress. Your Mortgage looks at some of the long-term strategies to consider so that you can avoid being stretched financially beyond your means

The Reserve Bank’s decision to raise the cash rate by a further 25 basis points to 7.25% in March has left a sour taste in the mouths of Australian homeowners. Many are finding it increasingly difficult to swallow the rising cost of jacked-up mortgage repayments. This latest hike marks the 12th rate rise since May 2002 when the benchmark rate was a mere 4.25%.Although ‘battlers’ were the first to encounter the damaging effects of mortgage stress, the pain has now seeped into middle Australia’s family groups – families who would not ordinarily be affected. Couple this with the tendency to overuse and underpay credit card balances and the impact of higher rates becomes impossible to ignore.

Stressed to the limit

The Australian Bureau of Statistics defines mortgage stress as occurring when a borrower pays more than 30% of their household income towards servicing a home loan.

According to Martin North, managing consulting director at Fujitsu Australia and New Zealand, a recent mortgage industry survey shows that this year’s interest rate hikes have already pushed Australia’s mortgage stress to record levels.

“The global credit crunch combined with recent rate rises, strong domestic inflationary pressure and rising petrol prices spell worrying times across Australia as families try to balance their budgets,” says North. “Young families have been impacted in particular by these factors while the fall in share prices has also added fuel to the fire.”

Fujitsu’s survey estimates that approximately 300,000 Australian homeowners could lose their homes within six months if mortgage rates continue to escalate. While mildly stressed households are managing to make mortgage repayments almost on time, they are also resorting to borrowing heavily on credit cards and severely curtailing their spending.

“People in severe stress are significantly behind with their mortgage payments, funding their day-to-day expenses through credit card debt, and are either entering default proceedings or trying to sell up,” says North.

Prevention is better than cure

According to Robert Projeski, managing director, Australian Mortgage Options, in order to avoid becoming another statistic, before you even commit to a mortgage, ask yourself seriously – are you overstretching? “It is easy to be dazzled by your dream home when you see it,” Projeski says. “You can already visualise having friends around for dinner by the pool, enjoying postcard views from the terrace. The possibilities dominate your common sense and you’ll be tempted to do anything to own it and live out your dream. The flipside is being stretched financially and leaving little or no room for changing circumstances, like a growing family, interest rate rises and unexpected costs.”

North agrees that many people are initially in a state of denial. “They may have refinanced over the last year and are again finding it difficult to meet their mortgage repayments. This being the case, they are twice as likely to experience stress over the following 12 months.”

The RBA’s last increase in interest rates plus independent rate rises by the banks mean that a homeowner with a $300,000 loan taken over 30 years will now have to pay an extra $69 per month if the interest rate rises from 8.95% to around 9.27%.

Borrowers who are starting to feel the strain should approach the right people at the outset of a potential default to avoid bigger problems down the line.

It’s vital to speak to your lender at the first signs of trouble in order to negotiate a payment plan. If this doesn’t relieve your woes, speak to a broker who may be able to suggest viable options such as refinancing with another lender who is offering a more competitive interest rate.

The short-term fix

A dollar in the hand is worth two on your loan

Cut back on discretionary expenses and curb your spending habits by creating a weekly or monthly budget. Also ensure that you understand exactly what fees and charges you are paying and how they can be minimised.

As simple as it sounds, we tend to fall into the trap of losing track of how and where we spend our cash. Once you are able to pinpoint exactly where your money is seeping out, you can make the necessary adjustments and plug the leak.

For instance, if your mortgage repayment has increased by $35 per week and you’re a coffee drinker or tend to buy your lunches most days during the working week, it only takes refraining from buying several takeaway lunches and making your own coffee to save that amount. You can also save petrol money by catching public transport a few days a week. For smokers, cutting back on three packets a week (or better still, quitting altogether) will save those funds.

Exercise credit control

The temptation to thrash the plastic to support monthly bills and regular

expenses is a big mistake, even when you’re not overstretching. Given the extremely high rates of interest levied on your credit card balance, your priority should be to keep on top of your monthly repayments by reducing the total amount rather than relying on your card. Consider switching to a credit card with a zero-interest balance transfer rate, which will provide you with a brief interest-free respite.

Split the risks

Unfortunately, rate fluctuations are inevitable. While analysts hint that locking yourself into a higher rate may be a futile exercise, considering we are already experiencing an upward interest rate cycle. A more viable alternative could be to split your loan between fixed and variable rates. Providing the best of both worlds, fixing a portion of your loan can give you some security against imminent rate rises while still retaining a degree of flexibility.

Calculate what your mortgage repayments will be over the next few years, but bear in mind that this will not completely take into account changing lifestyle factors you have little or no control over. These include losing your job, divorce or sickness, having a baby, losing a family member or spouse, or moving interstate.

The long-term fix

Direct salary crediting

This consists of having your salary directly credited into your loan account on a weekly, fortnightly or monthly basis. A loan cash-back, or redraw, will provide funds as required.

From the day you credit your mortgage account with your salary, you will be saving interest, reducing your repayments and whittling down the overall length of time it would take to pay off your loan.

Refinancing

The option to refinance your home loan is a long-term strategy that works by lowering your regular repayments or building equity more rapidly. This is a great way to save money provided you take into consideration the actual cost of refinancing into your calculations. Refinancing will always cost money. If you are experiencing financial difficulties now, you will nearly always be better off financially if you can come to an arrangement with your existing creditors. If you can’t negotiate an arrangement yourself, get advice from a broker or a financial planner before you make any hasty decisions.

A word of caution: refinancing your credit card debts might work to provide a short-term reprieve for out-of-control finances, but it usually won’t save you money in the long term, and won’t stop you running up more debt afterwards, particularly if you are struggling to make higher home loan repayments.

Make the switch

Switching to fortnightly instead of monthly repayments automatically creates an extra two payments per year, reducing the amount of interest you will pay over the life of your loan.

Most mortgages offer borrowers the option of making extra repayments each month towards the principal of their mortgage. These additional contributions will save you time and money on interest in the long run while helping to build equity faster.

As a rule of thumb, the more extra repayments made, the bigger the reduction of the mortgage principal. Consult your lender about the terms of your mortgage, which may stipulate certain fees should you exceed a set number of extra repayments per year.

Projeski advises anyone currently locked into a mortgage or contemplating buying into the property market to seriously consider their current lifestyle and future changing circumstances, and not commit to a mortgage they can’t handle. “After all, you want to be able to enjoy your property, not just stress about the repayments,” he says.

For homeowners who are experiencing the after-effects of the most recent rate rise, it may be time to sell up and downsize to a smaller residence.

Rent the spare room

Renting out one or more rooms can be an excellent short- or long-term way to positively counteract crippling mortgage repayments.

For empty-nesters living in large homes that no longer require all that extra space to accommodate families, or first homebuyers who are looking for innovative ways to reduce the financial impact of interest rate rises, renting out a spare room to a lodger or student is an excellent way to lessen the load.

Exploring online ‘flatshare’ websites, like Flatmate Finders, will give you an indication of the going rate of rental prices in your area and the type of people looking for accommodation. Most of the capital cities are currently in a state of rental crisis. Rents are rising consistently alongside rates and all types of accommodation are in high demand. You may be surprised at the rent you can get for that spare room that’s lying unused at the moment.

Alternatively, weigh up the prospect of letting out your own home and renting a smaller or cheaper property so you can draw in an income while saving on monthly outgoings.

Ensure a written agreement is drawn up prior to a tenant moving in. The main cause of disputes is money, so remember to include all the necessary details including:

Deposit and weekly or fortnightly rent amount and payment deadlines

Which rooms or facilities the lodger is entitled to use

Services you agree to provide

Share of household bills

Period of agreement

Notice period

Any other conditions you wish to include specific to your situation

Reverse your mortgage

A reverse mortgage is an equity-release product that allows asset-rich, cash-poor retirees 55 years and above to borrow a percentage of the value of their home to fund their retirement. The money is paid to the borrower as a series of instalments, a lump sum or a line of credit that can be drawn down at leisure.

Reverse mortgages allow borrowers to access cash while continuing to live in their home and retaining ownership of their property. However, on average, reverse mortgage interest rates are at least 1% higher than the rate charged on a standard variable home loan.

This is a complex option, and retirees should always take into consideration their health, probable lifespan and changing lifestyle circumstances. Contemplate how your needs and lifestyle will change over time and whether your obligations under a reverse mortgage will pose too great a burden. It is also imperative to seek advice from an independent solicitor or financial adviser who understands reverse mortgages prior to signing any legal documents.

“Builders and boomers largely missed out on the ‘superannuation guarantee’ scheme so have not built up their superannuation savings during their working years to the necessary level to fund a long retirement,” says Kieren Dell, executive director of the Senior Australians Equity Release Association of Lenders, or SEQUAL. “For many of these people, their home is their biggest financial asset as well as being a lifestyle asset. It is absolutely critical that they understand all their options for releasing the equity from their home to fund their retirement if they need to.”

While reverse mortgages offer asset-rich, but cash-poor seniors access to funds to support their retirement, there are serious downsides. Upon default, a lender may be authorised to request immediate payment of the entire loan balance and may impose penalty charges until paid. Additionally, the lender may initiate proceedings to sell your home.

Don’t wait

Michael Lee, director at Mates Rates Mortgages, encourages consumers to speak to their lender first if they are at all worried about meeting mortgage repayments. Failing any positive action on that front, borrowers should contact their state government’s department of fair trading.

“For those who are already finding it difficult to make their regular repayments, take immediate proactive steps,” says Lee. “Examine your ingoings and outgoings and then consider the available options for your situation.”

Lisa Montgomery, consumer advocate at home loan specialist Resi, agrees that the biggest mistake borrowers make is calling their lender when it’s too late.

“Most borrowers will have an idea well in advance and should call their lender before anything happens,” she says. “More than likely it will be a combination of events such as an increase in rates in tandem with another event such as job loss or unforeseen financial commitment.”

She adds that it is natural for a borrower to “bury their head in the sand and hope that things improve” – but in reality this strategy rarely works. Quite the contrary. Many borrowers who ignore escalating financial woes find themselves getting deeper and deeper into debt by using a series of credit cards to “prop up their lifestyle”. This is not a solution. It is merely delaying an inevitable disaster.

Montgomery says there are some good strategies that can be suggested by your lender to assist you in getting back on your feet.

“Things like debt consolidation, changing to interest-only or in extreme situations ‘making an arrangement’ for reduced payments for a time can be worth exploring,” she says.

“Each and every borrower is different and you should only consider selling your property if and when you have exhausted every option. It’s the last thing you want and it’s the last thing your lender wants.”

Hanging on to your home – in most circumstances – is the preferred outcome. However, once all aspects of the situation are assessed and all options have been exhausted, selling the home may relieve a significant amount of pressure. For a minority of homeowners this may indeed be better in the short to medium term.

Whatever the outcome, talking to your lender is the first step. In fact even if there is no material sign that a problem is near, calling your lender just for peace of mind will help you sleep a little better at night.

Whether you are looking to buy your first home, move home, refinance, or invest in property, a mortgage broker can help. Access loans from all the major lenders, get help with paperwork – plus there is no charge for this service. Get help from a local mortgage broker

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